DSM Shareholder Incentives: Recent Designs and Economic Theory
U.S. utility DSM shareholder incentives represent a unique form of targeted incentive regulation designed to motivate utilities to achieve specific energy-efficiency objectives. Through a review of recent DSM shareholder incentive designs and earnings for 10 U.S. utilities, we conclude that the mechanisms could be improved by harnessing their incentive powers more deliberately to ensure better alignment of regulatory objectives and utility financial self-interest. Better alignment reduces adversarial confrontation and eliminates the need for regulatory micro-management. We make five specific recommendations: (1) apply shared-savings incentives to DSM resource programs (2) use markup incentives for individual programs only when net benefits are difficult to measure, but are known to be positive (3) set expected incentive payments based on covering a utility's ‘hidden costs,' which include some transitional management and risk-adjusted opportunity costs (4) use higher marginal incentives rates than are currently found in practice, but limit total incentive payments by adding a fixed charge (5) mitigate risks to regulators and utilities by lowering marginal incentive rates at high and low performance levels. As regulators and utilities contemplate new forms of regulation for a restructured electricity industry, the lessons from the U.S. experience with DSM shareholder incentives are readily generalizable: Be explicit about the regulatory objective when considering multiple objectives, look broadly at alternatives that have the potential to meet these objectives without compromising the incentive properties of the mechanisms.